06252009 MSFT Tech Guarantee Tami Reller
MSFT Tech Guarantee
Tami Reller, Corporate Vice President and Chief Financial Officer, Windows Client Division
June 25, 2009
OPERATOR: Welcome to the Microsoft Conference Call, and thank you for standing by. At this time, all participants are in a listen-only mode. During the question and answer session, please press *1 on your touch-tone phone. Today's call is being recorded. If you have any questions, you may disconnect at this time.
I'll now turn the call over to Mr. Kevin Green.
You may begin.
KEVIN GREEN: Good morning, everyone, and thanks for joining us today. I'm joined on the call by Frank Brod, Corporate Vice President of Finance and Administration, and Chief Accounting Officer; Tami Reller, Corporate Vice President, and CFO of our Windows Client Division; and Keith Dolliver, Associate General Counsel.
Earlier today, Microsoft announced the availability of the Windows 7 Upgrade Option Program. We also announced today worldwide availability dates, and retail pricing for Windows 7 you can find more information about these announcements on the Windows Team Blog at www.WindowsTeamBlog.com.
The purpose of the call today is to help you understand the financial statement impacts of the Windows 7 Upgrade Option Program. On today's call, Tami will provide some background on the Windows 7 Upgrade Option Program. And Frank will then walk you through the accounting treatment and the impact to the financial statements. You can get a slide deck for today's call on the Investor Relations Web site at www.Microsoft.com/msft.
We are offering the call to provide some background information and an opportunity for you to ask questions specifically regarding today's Windows 7 Upgrade Option announcement. We will not be discussing quarterly results, or any topics beyond this announcement today. Chris Liddell will join you for our fourth quarter earnings call on July 23rd, and we'll update you with the results for the quarter at that time.
This call is being recorded. If you ask a question, it will be included in both our live transmission as well as any future use of the recording. A replay of the call will be available on the Microsoft Investor Relations Web site through close of business on June 25th, 2010. This call is the exclusive property of Microsoft. Any redistribution, retransmission, or rebroadcast of the call in any form without express written consent of Microsoft is strictly prohibited. We may make forward-looking statements during this call. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially because of factors discussed in the filing with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements.
Again, thanks for joining us today, and now with that I will turn it over to Tami.
TAMI RELLER: Great. Thanks, Kevin.
And good morning, everyone, we appreciate you joining in today. Earlier today we announced a Technology Guarantee program for Windows 7, and which we're calling the Windows 7 Upgrade Option Program. The concept of these programs is not new to Microsoft. We have offered them in the past on our previous releases, including with Vista. And like previous technology guarantee programs, this program is specifically designed to enhance the customer satisfaction and support current sales for both our hardware and retail partners until Windows 7 general availability on October 22nd, a date we announced a bit earlier.
Starting tomorrow, the Windows 7 Upgrade Option enables consumers and small businesses to receive Windows 7 when they purchase a qualifying Windows Vista personal computer, giving them the opportunity to enjoy a new PC now, and receive the benefits of Windows 7 when it is released in October.
So, under the Windows 7 Upgrade Option Program, customers who purchase these qualifying versions of Windows Vista will have free version rights to their comparable Windows 7 version. Specifically, to use some examples, Windows Vista Home Premium will have free version rights to Windows 7 Home Premium. Windows Vista Business will have free rights to Windows 7 Professional. And Windows Vista Ultimate will have free rights to Windows 7 Ultimate.
This program is available to all OEMs for computers shipping with these versions of Windows Vista from June 26th, 2009, through January 31st, 2010. Retail packaged Windows Vista software products may also qualify for an upgrade to the equivalent Windows 7 product with participating retailers in participating markets. Some shipping and handling costs, and some other fulfillment costs may apply. So, consumers will want to check with their local computer manufacturer or their retailer for additional program details that may apply.
So, all in all, we're very excited about the upcoming Windows 7 launch, and, again, starting tomorrow, this program will enable customers to take advantage of the benefits of a new PC, and the reward of receiving Windows 7 when it becomes available in October.
Now, I want to turn the call over to Frank, who will walk through some important financial reporting impacts of the Windows Upgrade Option Program.
FRANK BROD: Well, thank you, Tami.
I would like to spend a few minutes talking about the accounting impact for the program in order to help you understand the impact on our revenue recognition. Under the Windows 7 Upgrade Option Program, we're essentially offering free rights to a future software product, Windows 7, with a qualifying purchase of Windows Vista. And for accounting purposes, this transaction is treated as the sale of two distinct products, with the total sales price being allocated between each product based on their relative pro rata fair value, which we expect will be approximately 50/50.
The revenue allocated to Windows Vista is recognized on the date of the sale, while the revenue allocated to Windows 7 must be deferred, and it's recognized upon the earlier of either the fulfillment date, or the expiration of the program. So, as a result, Microsoft will defer approximately 50 percent of the revenue from eligible sales under this program.
For accounting purposes, fulfillment will occur in one of two ways. First, for our large OEMs who are managing the process directly with their customers, the fulfillment criteria is met by Microsoft once we've released Windows 7 and deliver the licenses to the OEMs in the second quarter of Fiscal 2010. And, second, for OEM and retail license sales where Microsoft is managing the fulfillment process, the fulfillment criteria is not met until we actually ship the Windows 7 license to the end customer.
We expect to recognize the majority of the revenue deferred from the fourth quarter of Fiscal Year '09, and the first quarter of Fiscal Year '10 when we ship Windows 7 in the second quarter of Fiscal '10. The remaining deferred revenue will be earned in the second half of Fiscal '10.The deferral only impacts the timing of revenue recognition, and will not have any impact on cash flows from operation.
When assessing the revenue recognition impacts, you can use the following framework to calculate the impact on your models. Begin by estimating the total Windows Vista Premium sales for the duration of the effective period of the program, and then back out an estimate for units covered by client software assurance. Software assurance customers will receive Windows 7 through the Software Assurance Program, and this revenue is already subject to deferral. The difference between the premium sales less the software assurance licenses represents the units which are subject to the deferral rate of 50 percent.
And for the fourth quarter of Fiscal 2009 we estimate that between $200 and $300 million of revenue related to the program will be deferred with a corresponding increase in unearned revenue on the balance sheet.
When thinking about the size of the fourth quarter impact keep in mind that the majority of the deferral relates to licenses currently in inventory at our OEMs, and at the retailer. When modeling the revenue recognition impact for the first quarter of Fiscal '10, the methodology will be consistent with the framework outlined earlier.
And now we have some time left to answer your questions. Again, we ask that you please restrict your questions to items covered in today's call.
(Operator Direction.)
ADAM HOLT, Morgan Stanley: Good morning. Thanks for taking my question. I had two questions. First of all, can we assume that the OEM pricing is going to look like the retail pricing for the different SKUs? And then secondly, can you walk us through your thinking around some of the price changes for the premium version?
TAMI RELLER: Yes. Thanks, Adam. So on the OEM pricing, obviously we don't really comment on our OEM pricing. The announcements that were made today were centered around the opportunities we were going to give customers through the upgrade of Windows 7. So that's really the focus of today's announcement. And then on your premium question, can you just re-ask that again, so I understand what your angle is?
ADAM HOLT: Sure, I'm just trying to ‑‑ there are obviously some price changes for upgrades for the premium version. I was trying to understand what the rationale was for that.
TAMI RELLER: Yes, so the idea behind the premium SKUs with Windows 7 holistically, and then that is reflected in the pricing, is to really make sure that the customers get the premium experience that will best give them what they need, which is why we've put a lot of focus on home premium in the developed markets. It's why we have included the premium version in this upgrade option program, as well. To make sure that customers can receive the benefits of Home Premium, that's why that's why we've made the slight price decrease in Home Premium with Windows 7, to make sure that customers who want to benefit from that can take advantage of that.
Kevin Green : Thanks, Adam.
Next question please.
(Operator Direction.)
SARAH FRIAR, Goldman Sachs: Great, thanks for taking my question. I just want to be ‑‑ make sure we're clear here. When we think about the deferrals, Tami, effectively everything will be returned back to the P&L in your second quarter, in the December quarter. Is that the right way to think about it?
TAMI RELLER: Largely, and Frank and I can both speak to this. So why don't I have Frank talk about actually how it flows, and how to think about that.
FRANK BROD: Yes, Sarah, the fulfillment process with the large OEMs will pretty much be satisfied in the second quarter of Fiscal '10 when we deliver the Windows 7 to our customer, which is the OEM. However, where we're selling through the retail channels and through some of the other OEMs, the fulfillment process won't be until we actually provide Windows 7 to the customer, and they have until the end of January to do that. So, we'll have some deferral into the third quarter, and probably a few bits into the fourth quarter of Fiscal '10. But, in your modeling you can think of the bulk of it happening in the second quarter.
SARAH FRIAR: Got it.
TAMI RELLER: The only thing I would add is we wanted just to make sure that this program was truly worldwide and very accessible to consumers broadly, OEMs broadly, and many retailers. And so to do that there's multiple mechanisms for fulfillment, and that's why you'll see a little bit trickling into Q3.
SARAH FRIAR: Got it. And then just as a follow up, to be clear, as well, this does not impact any of the revenue that comes under SA. This is OEM and retail only that we should be thinking about in the models, so probably about 85 percentish of total?
FRANK BROD: That's right, yes. The volume licensing, the software assurance, will continue as it is, which is already subject to a deferral process.
SARAH FRIAR: Got it. Okay, great. Thanks for doing the call.
TAMI RELLER: You bet.
(Operator Direction.)
BRENDAN BARNICLE, Pacific Crest Securities: Great, thanks. I was hoping we could just go on that pricing, just back to where this price decrease would be relative to where XP pricing had been?
TAMI RELLER: Say it again, I want to make sure I understand your question.
BRENDAN BARNICLE: Sure, I was just trying to get a sense on, given the change in pricing, how that ‑‑ what that looks like, relative to where the Windows XP pricing that's still in the market would be, particularly as it relates to netbooks.
TAMI RELLER: Yes, we really have not announced that piece of the pricing model. We're really focused today on where the Home Premium offering would be, and in FPP specifically.
BRENDAN BARNICLE: Okay, that's all I had. Thank you.
TAMI RELLER: Okay, thank you.
(Operator Direction.)
DAVE HAVTERON, JP Morgan: Hi, thanks for taking my call. This is actually Dave Havteron for John DiFucci. I think Adam and Sarah already sort of asked the question I was looking to ask, but I guess just a couple of quick little follow ups. Just, can you remind me the expiration date of the program, also I take it you can't, but is it possible to provide any sort of idea of the magnitude of the deferral amount for the September quarter? And then maybe, I don't know, Frank, just sort of hit on again the nuance with regard to software assurance, just to make sure I'm clear about it if possible. Thanks very much.
TAMI RELLER: Let me cover dates, and then I'll have Frank pick it up from there. So it runs through January 31st of next year.
FRANK BROD: And as far as the amount of the deferral for the first quarter, I think you first have to think about what are your assumptions for the underlying PC market growth. That's really the biggest driver here, how that impacts both the retail and the OEM channels. Maybe to give you some impact, if you recall when we had the Windows Vista program, which was about for one quarter, we deferred approximately $1 billion during that program from the second quarter of '07 into the third quarter of '07. So maybe that can give you some idea of what, based upon the number of PCs that were sold in that timeframe, what you might expect in the next.